Key U.S. Inflation Reading Helps September Rate Cut Advocates

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The Federal Reserve can consider an interest rate cut in September according to analysts reacting to a key inflation reading that has fallen to a three-year low.

The U.S. Core Personal Consumption Expenditures (PCE) index rose by just 0.083% month-on-month in May said the BLS, down from an upwardly revised 0.3% in April. The figure was in line with consensus (0.1%) and helped the annual rate fall to 2.6% from 2.8%, a three-year low.

Because the figure met expectations there was limited reaction in bond and currency markets. However, these data will help build the case for the Federal Reserve to cut interest rates in September, say some analysts.

"The return to the earlier disinflationary trend and new-found weakness in real activity, are both consistent with the Fed cutting interest rates as soon as this September," says Paul Ashworth, Chief North America Economist at Capital Economics.

The PCE index is a measure of inflation that is particularly relevant to consumers and is, therefore, closely watched by the Federal Reserve. "Federal Reserve officials, responsible for managing inflation, prioritise the PCE index over the Consumer Price Index (CPI) when determining the influential federal funds rate," says Nigel Green, CEO of deVere Group.

Finessing the figures further gives us the “supercore” measure - core services excluding housing rents - which decelerated to 0.1% m/m, the slowest since August. Today's dataset also contained numbers showing consumption is slowing owing to high interest rates. Real consumption increased by 0.3% m/m in May and second-quarter consumption growth is now tracking at only 1.6%.

Capital Economics estimates GDP growth is now down to 1.8% for the second quarter, "which would cap a weak first half of the year. Like Biden, consumers appear to be faltering at just the wrong time, finally capitulating under the pressure of higher rates," says Ashworth.

"This is exactly what the Fed wants to see, and I think it’s clear now when taking a broad view of the data that the trajectory for inflation is firmly downwards. For the September cut, though, we’ll really need to see a few repeats of this sort of number over the next two or three prints to convince the Fed that 2% is within their grasp," says Kyle Chapman, FX Markets Analyst at Ballinger Group.

However, deVere Group's Green says the Fed will want to see more months of positive data before cutting interest rates. "Our previous prediction that the Federal Reserve would not cut interest rates until 2025 is now seemingly gaining traction among an increasing number of policymakers too."

Federal Reserve policy setter Michelle Bowman said this week, "we are still not yet at the point where it is appropriate to lower the policy rate. Given the risks and uncertainties regarding my economic outlook, I will remain cautious in my approach to considering future changes in the stance of policy."

She also revealed that she is one of several Federal Reserve policy setters who sees no cuts this year, making her one of four Fed policymakers who think rates will remain unchanged.